In July 2012, Mark Zuckerberg financed his 5.95 million dollars Palo Alto home, that’s 3 miles away from Facebook’s headquarter with a 30-year Mortgage. At that time he was 28 years old and the world’s 40th -wealthiest person, worth an estimated $15.6 billion.
The question is, why would you get into debt when you have billions of dollars and can easily afford it? If he wanted, he could easily buy a dozen $6 million homes, in cash, without batting an eye. So why get a mortgage? The answer is long and complicated but in short, it’s- Free Money!
The Free Money
Sounds ridiculous, who would give you free money when you are already a billionaire? Let me explain, It all has to do with interest rates. The inflation rate in the US is 2.5 to 3 percent, so any money you borrow that is below the inflation rate is considered free money.
Zuckerberg’s mortgage rate is just a little over 1.05 percent but it is adjustable, meaning that, base on the circumstances the rate could go up for one reason or another. If you do the math, the bank is the loser since the mortgage rate is below the inflation.
You don’t have to be the genius to do the math. For the sake of example, let’s say you borrow 1 million dollars at a rate of 1 percent. The average rate of return on the savings account is 2.4 percent. Meaning that Even if you deposit that million dollars in another bank, you end up making $24 000 dollars a year while you only have to make a monthly payment of $10500 to the bank that lent you that money.
Imagine if you do that with a hundred million dollars, or how about a billion dollars! When you can borrow for free, there’s no point in tying up your own money, when you can use that money for more profitable things.
Of course, when we are talking about small amounts of money, this might not make sense, because the difference isn’t that big, however, when it comes to large sums, playing around with 1, 2 or half a percent could potential mean dozens of thousands of dollars if not hundreds.
Let’s say you are a businessman, and you can easily afford a million-dollar house, why buy a house when you can finance it for 1 or 2 percent while you invest the rest of that money in your business that could potentially get you 10, 20 if not 30 percent returns.
Even if you are lazy to find a more profitable way to use money, just throwing it all into an index fund can be much more profitable. Especially when we are talking about 20 or 30 years. Historically an index fund has shown to have an average return of 8 percent. If you take a mortgage and invest your money in an index fund, the percentage difference will end up in your pocket.
Opportunity cost Economically
It all comes down to Opportunity cost Economically, it wouldn’t make sense for Zuckerberg to buy the house in cash when he has been offered a 1 percent mortgage rate. But he is not the only one who is so smart to do that.
Take Elon Musk for example, Most of his wealth is tied to Tesla and SpaceX, to buy a house for 20 million dollars, he probably might need to sell a considerable chunk of his wealth, pay taxes and incur other expenses, however, he can take free money and keep his monthly payment under his budget.
He took out a 61 million dollar mortgage for 5 properties in California with a monthly payment of 180 thousand dollars. That’s not unique to billionaires, it is also practiced by moderately rich people like Jay Z and Beyoncé.
They took a mortgage to buy their 88 million dollar house. They put 40 percent down payment and financed the other 52.8 million dollars.
That leaves the couple with a 149,600 dollars monthly payment. In comparison, The national median home value is $200,700.
Instead of tidying 53 million dollars in a house, he knows where to invest it, to maximize his profit, at the end of the day, He has made a lot of great investments, and he is on his way to becoming a billionaire. The richer you get, the better ways to find to make more money.
But let’s be honest, not everyone gets such a low mortgage rate, nationwide it is around 3 percent, but even at that rate, it still doesn’t make sense to purchase a house if you can finance it.
But let’s get this clear first! why do the super-rich get a lower rate than the rest of the country? First of all, when you are a billionaire, the bank can sleep calmly because no one is worried that you might default on your loan and in case if something happens, you can easily sell part of your business to pay back your mortgage, that takes out the risk out of the equation.
Compare that to an average employee who could get sick and not be able to work or just lose his job. Secondly, Paying your mortgage on time every month helps you build and maintain a healthy credit score, so when you are in trouble next time, with a strong credit score, it will be much easier to borrow money from the banks.
You are building trust between you and the financial institutions. But it could also be the other way around. Banks do offer such a low mortgage rate to establish a strong relationship with rich people so that when their companies would need a loan from a bank, they would come to them and not their competitors.
It’s a win-win situation. But these low mortgage rates are adjustable which means as I said earlier, they could go up! but no one is worried because if it stops making sense economically to these ultra-rich people, they easily can pay back their mortgage.
But Most people associate debt with something negative because we usually borrow money that we can’t afford for entertainment and end up paying a lot more back. Right after getting out of college, you realize what a burden your student debt is already.
Is Debt Bad?
And once you calculate how many years you have to pay back that debt, you immediately create a perception that- DEBT IS BAD. Especially when you can’t even default on it. Playing around with debt is not easy, you are eventually taking a huge risk and a small miscalculation can lead to disastrous consequences.
We have got into so much debt that most people now can’t even afford an unexpected 500 dollar bill because we have to make all of these monthly payments.
However, that’s what distinguishes bad debt from the good one. Debt can ruin your life, make you homeless and cripple your family if you are reckless but it can also make unbelievable rich if you know how to use it because it is Leverage. Leverage is a superpower that can make you rich instantly.
How you make money when you don’t have money
Let’s say for the sake of example, you buy this phone for ten thousand dollars, go to the market and sell for it 11 thousand dollars, congrats, you just made a profit a thousand dollars, however, that’s not much.
But what if you use leverage, you go the bank first, borrow 990 thousand dollars, with your additional 10 thousand dollars, that’s going to be a million dollars.
You head to your supplier and buy a hundred phones now for a million dollars, turn around and sell it to the market for 1 100 000 dollars. But you still owe the bank, so you go back to the bank again and return them 990 000 thousand dollars that you borrowed and another 10 thousand dollars in interest.
Now you are left with a hundred thousand dollars. After you deduct your own 10 thousand dollars, you are left with 90 thousand dollars of pure profit.
That’s how you make money when you don’t have money. The bank made their share of the profit and you made yours. Of course, when you take this formula to the extreme and it’s not regulated by the government and practiced by everyone in the wall street, it turns into a financial crisis, as it happened in 2008.
Remember when home prices crushed?! and then they took down the entire economy with them?! Well, it is because the investment banks used leverage to maximize their profit to the point where their strategy backfired!
Because they began giving a mortgage to people who didn’t necessarily have the best credit score and weren’t financially prepared to make the monthly payments.
And then they defaulted on their mortgages, it was a nightmare for the investors because for the last 40 years, home prices were rising and suddenly, they were going down.
Well, we are not going to get into the details of the 2008 financial crisis, that’s a story for another article but in anyways it’s still a major tool of how rich people make money.
Of course, it’s risky and you can end up losing everything, but if you know what you are doing, you can make a fortune overnight.